Playing the Presidential Cycle

Whether you are an ardent bull or fervent bear, it's hard to dismiss the latest round of economic numbers out of the U.S. as anything but constructive. The columns may be filled with continued talk of how much drag America's unemployment is, but the trend has been positive now for two years. Case in point, this week's report on jobless claims showed the lowest number of initial filers since March 2008, at 348,000.

This has translated into a decline in the total on claims to 3.426 million, which is the smallest since August 2008. Likewise, the insured unemployment rate has tumbled to 2.7 per cent from almost five per cent back in the dark days of the recession in 2009. To put this into perspective, this is slightly below the rate we saw when Americans went to the polls in November 2008 to elect Obama as president. True, the actual unemployment rate (8.3 per cent in January) is higher than the 6.5 per cent rate at the time of that election; however, there is typically a lag between what we see in the unemployment insurance data and officially reported unemployment, so it's possible the national rate could fall well below eight per cent before this November.

On top of what the trend in employment, there has also been a revival in business and consumer confidence, together with improved orders for capital goods and generally more favourable housing market indicators. This past week, the U.S. reported that a further decline in the percentage of mortgage delinquencies to 7.58 per cent in the fourth quarter and a similar improvement in mortgage foreclosures to 4.38 per cent. Delinquencies had reached above 10 per cent back in 2010 and the foreclosure rate peaked at over 4.5 per cent that same year. To the extent the stock market is a barometer of economic health, voters will likewise feel some relief from the fact that equities have recovered almost all of the lost ground from the spring of 2008 to March 2009. This week, the S&P 500 hit a high of 1363, matching the closing high from last April, where the high in May 2008 was 1425. When Obama was elected, Americans were in deep despair after watching the S&P sink to 800. Of course, markets could easily reverse course before we get to the November polls, but if we were to see the S&P crack 1400, most technicians would agree that there would be little in the way of resistance between there and those lofty days of before the crash when the S&P reached a record high 1565.

Note, I could have replaced Obama's name with "incumbent," since the reality of the situation is that it is not the individual that will win or lose a U.S. election but the economic baggage that one takes into the vote. Just as a reasonably well-heeled president like Bush Sr. was able to lose against Clinton, and his totally less-heeled son was able to win a second term, it was the economy that guided voters' hands in the polling booth. The Republicans have only made it easier for Obama to win re-election this year, with the almost ridiculous antics captured during the primaries and debates, but it wouldn't have mattered much had that not been the case. The only thing that will derail a second-term Democrat administration is a sudden pullback in the economy and/or stock markets.

The irony is that the improved conditions that we are witnessing today, the ones that will likely engineer an Obama victory, are the same ones that will potentially work against the economy during his second term. I'm referring to the inevitable hangover from an excessively long party with zero interest rates. Now that stocks have started to build momentum, the next thing which will happen is that folks with bonds will begin to get fed up (pardon the pun) with stupidly low yields and venture into the warmer waters of the equity market. This, plus the higher risk of inflation, will send bond yields higher into the election, creating an environment of higher mortgage costs in 2013. Not that I expect a major whipsaw to the overall economy, but given that household leverage is still high and we're not exactly cranking out the type of employment and income growth normally associated with a recovery, any lift in mortgage rates could easily knock the housing market down. A worst-case scenario is that a more aggressive sell-off in bonds that not only sends a shockwave through housing, but takes out a number of investment funds that were too long duration in their bond portfolios. Either way, the champagne from a Democrat re-election could turn flat very quickly.